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Thursday, April 23, 2015

Desperately Seeking Stacking: Guest Post by Jorge Contreras

Posted by
Camilla Alexandra Hrdy

In this Guest Post, Jorge Contreras, Associate Professor of Law at the University of Utah College of Law, discusses the lack of reliable sources of data regarding the existence of patent royalty stacking, and makes a public plea for firms to disclose more of their patent royalty data in order to permit the academic community to assess it.

The question of royalty “stacking” has recently become the subject of debate both in the courts and the academic literature. Stacking refers to a hypothetical situation in which multiple patent holders each charge a royalty on the sale of a product, often one that implements key industry standards such as Wi-Fi and 4G. Even though each individual royalty demand might, in isolation, be considered reasonable, the aggregate of all royalty demands could become excessive in relation to the product’s overall value, thus raising consumer prices, depressing manufacturer profits, impeding market entry, and the like. The prospect of stacking has been understood in the economics literature for more than a century (it emerges from the well-known problem of Cournot complements), but has received renewed vigor within the last decade.

The debate over royalty stacking occurs along several axes. The first of these concerns the number of patents covering a particular product. As to contemporary consumer electronics, telecommunications and computing products, it is generally acknowledged that many, many patents exist. While there is debate over the actual number (in 2011 RPX famously, and controversially, estimated that a single smart phone is covered by approximately 250,000 patents), nobody seriously denies that a stack of patents lies behind most electronic devices on the market today.

The most important question, however, is not how many patents exist, but how high the aggregated royalty demands attributable to these patents are. Here, the facts on the ground become harder to discern. Why? Because almost all patent royalties are buried in bilateral licensing agreements between patent holders and product manufacturers, and these agreements are subject to strict confidentiality protections. Thus, while Company A and Company B may know the rates that A charges B for a certain patent portfolio, B has no idea what A charges C for the same portfolio, and A does not know what B pays to D to use other patents covering the same product. And while industry veterans have a sense for the appropriate royalty ranges in their fields, hard data is remarkably hard to come by.

Scholars who study patent licensing have only a few reliable sources of data regarding royalty rates. These include licensing agreements that have become the subject of litigation and are thus exposed in open court (though a surprising amount of numerical data in these agreements is sealed through protective orders), and public filings with the Securities and Exchange Commission (SEC) in the U.S. (though, again, actual royalty rates are often granted confidential treatment by the SEC and hidden from public view). Unfortunately, the crumbs of data available through these means constitute only the tip of the iceberg. Most licensing agreements do not get litigated, and large firms are not required to file any but the most “material” agreements with the SEC. Thus, the vast majority of patent royalty data remains secret.

This degree of secrecy is problematic. First, it permits large patent holders to argue that there is no empirical evidence of royalty stacking. To a degree, they are correct. However, as noted above, this paucity of data is caused largely by their own unwillingness to share data with others. Second, it gives what scarce data exists undue prominence and helps to support conclusions based on little more than supposition and wishful thinking. For example, one argument that has recently been advanced to refute the existence of royalty stacking is that several large smartphone manufacturers (e.g., Apple, Samsung and Nokia) have enviably high profit margins (40%, 37% and 22%, respectively), and their profits would doubtless be lower if royalty stacking were a problem in the industry. This argument rests on a raft of dubious assumptions that do not do well under closer scrutiny. Namely, that these large firms’ profit margins are attributable primarily to their smart phone businesses, that their profits would not be higher absent royalty stacking, that they have not traded away their own valuable patent rights via cross-licenses to address stacking issues, that these firms are representative of the industry as a whole, that new entrants are able to enter the market and achieve similar profit margins, and that consumers are not paying higher prices as a result of royalty stacking.

The absence of meaningful and verifiable data on patent royalty rates hobbles the public debate over appropriate policies to govern industry standard setting and patent litigation. To date, far too much of this debate has relied on theoretical argumentation, political preference and positional advocacy, and has given undue weight to the scant data that is available.

To this end, there will soon be an open invitation for firms to come forward with their patent royalty data and permit the community to assess it in the light of day. I, together with others in the academic community, are seeking to inform the policy debate over patent royalty stacking with actual data, and hope that many private sector firms will join in the effort to shed light on this murky area.